Consolidated materials on Risk management & Risk Financing

1. Instructor- Dr.Riyaz Muhmmad
Whatapp: 00966502245998
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Introduction to Risk Management
Chapter 1
RISK

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 “Risk” may be defined as a compound measure of the
probability and magnitude of adverse effect.
 A risk is a potential problem – it might happen and it
might not
 Conceptual definition of risk
◦ Risk concerns future happenings
◦ Risk involves change in mind, opinion, actions, places, etc.
◦ Risk involves choice and the uncertainty that choice entails
 Two characteristics of risk
◦ Uncertainty – The risk may or may not happen, that is, there
are no 100% risks (those, instead, are called constraints)
◦ Loss – The risk becomes a reality and unwanted
consequences or losses occur

3.  One of the earliest references to the concept of risk
management in literature appeared in the Harvard Business
Review in 1956.
 Someone within the organization should be responsible
for “managing” the organization’s pure risks. At the
time that the term risk manager was suggested, many
large corporations had a staff position referred to as
the “Insurance Manager.”
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4.  Derived from the Italian word ‘rischio’, meaning a source of
peril, this everyday word is defined by the Oxford English
Dictionary thus;
1. A situation involving exposure to danger.
2. The possibility that something unpleasant will happen.
3. A person or thing causing a risk or regarded in relation to risk:
a fire risk.
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5.  To the layman, the term ‘hazard’ and ‘peril’
appear to be synonymous with ‘risk’. In fact
meanings are distinct:
 Hazard: A hazard is something probability of a
risk occurring.
 Peril: if the risks is physical damage a building,
then fire, storm, flood and earthquake are all
perils
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6. In risk management, a peril is the direct or
immediate cause of a loss (such as a fire or
automobile crash)
A hazard is a condition that increases the
possible frequency or severity of a loss, or both
Moral hazard: deceit, often involves insurance
Morale hazard: carelessness
Physical hazard: tangible conditions (snow, ice)

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 Known Risks
◦ Those risks that can be uncovered after careful
evaluation of the project plan, the business and
technical environment in which the project is being
developed, and other reliable information sources (e.g.,
unrealistic delivery date)
 Predictable risks
◦ Those risks that are extrapolated from past project
experience (e.g., past turnover)
 Unpredictable risks
◦ Those risks that can and do occur, but are extremely
difficult to identify in advance

8.  Weak Economies: GDP growing slowly or gone negative ( in Minus)
 Regulatory Risk: Rules can change at a moment’s notice.
 Increasing Competition: Increased competition from local and foreign
firms.
 Damage to Reputation: Corruption and bad press can destroy a
company’s image.
 Failure to Attract Top Talent- Due to Downsizing Policy of HR
 Failure to Innovate- lack of proper Budget for research & Development
 Business Interruption- Strike and lock out
 Commodity Price Risk- Due to variable cost
 Cash Flow & Liquidity Risk- Banking and financial institution
 Political Risk: Middle East politics lowering the price of oil ( Geo-
political risk)
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9.  ‘Risk is the inability to accurately predict the effects of
future events which might result in losses.’
 Risk or danger is present whenever human beings are
unable to control or foresee the future with certainty.
 Although, the precise future outcome is unknown, the
possible alternatives can be listed; such as "heads” or
“tails”.
 The chances associated with those possible alternatives
are also known; such as a 50% (50 percent) chance of
either “heads” or “tails”.
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10.  Fundamental Risks( Macro Risks)-These tend to
affect large numbers of people, perhaps areas of
countries, or whole countries, or even a number of
countries or a geographical region. ( Catastrophic risks)
 For example, cannot be controlled or influenced by
individual action. Incidences of volcanic eruption, tidal
waves and tsunami, floods, earthquakes, and similar
“natural”
 Another example of fundamental risk is the economy of a
country. That is because the effects of, say, “inflation” or
mass unemployment, are beyond the influence of
individuals.
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11.  Particular Risks (Micro Risks) - These refer to risks
whose future outcomes or effects can be partially
controlled (although not predictably) by individuals or
groups of people .
 For example, from an individual’s decision to drive a motor
vehicle, or to own property, or even to cross a road. Much
depends on the individual’s action and level of care (or lack
of care and attention).
 Particular risks are the responsibility of individuals,
 such risks are ‘insurable’.
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12.  The majority of insurable risks are what are called
‘pure risks’ which include fire, accidents, theft, etc,
which offer no prospect of gain, but only of loss if the
risk becomes a reality.
 Trading risks are called ‘speculative risks’ because they
offer the possibility of loss or gain, and in general they
are not insurable.
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13. Pure Risk: potential loss
but no possible gain
 Physical damage to property
from fire, flood or other natural
disasters
 Liability risk: getting sued over
products; employment practices
 Individual risk of mortality or
morbidity
 Manmade risks: war;
unemployment
 Global pandemics; social
program failure, COVID19
Speculative risk:
potential gain or loss
 Market risk: interest rate
fluctuation, foreign exchange
volatility, stock price
 Reputational risk
 Brand risk
 Individual credit risk
 Regulatory changes
 Accounting risk

14.  Diversifiable risks: risks whose adverse consequences
can be mitigated simply by having a diversified
portfolio of risk exposures (4T)
 Non-diversifiable risks: risks, shared by all persons or
organizations, that cannot be mitigated by adding
exposures to the portfolio

15. Diversifiable Risks
 Reputational risk
 Brand risk
 Credit risk
 Product risk
 Legal risk
 Physical damage risk
 Operational risk
 Strategic risk
( A kind of MICRO risks)
Non-diversifiable Risks
 Market risk
 Regulatory risk
 Environmental risk
 Geo-political risk
 Inflation and recession risk
 Pandemics,( COVID19)
 Social security program risks
( A kind of MACRO risks)

16.  Statistical measures that are historical predictors of investment
risk and volatility and major components in Modern Portfolio
Theory (MPT). MPT is a standard financial and academic
methodology for assessing the performance of a stock or a stock
fund compared to its benchmark index.
 Volatility refers to the amount of uncertainty or risk.
 According to the MPT theory, it's possible to construct an
"Efficient Frontier" of optimal portfolios offering the maximum
possible expected return for a given level of risk
 'Benchmark’-When evaluating the performance of any
investment, it's important to compare it against an appropriate
benchmark.
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17.  There are five principal risk measures:
Alpha: Measures risk relative to the market or benchmark index
Beta: Measures volatility or systematic risk compared to the
market or the benchmark index
R-Squared: Measures the percentage of an investment's
movement that are attributable to movements in its benchmark
index
Standard Deviation: Measures how much return on an
investment is deviating from the expected normal or average
returns
Sharpe Ratio: An indicator of whether an investment's return is
due to smart investing decisions or a result of excess risk.
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18. The risk inherent to the entire
market or an entire market segment.
Systematic risk, also known as “Un-
diversifiable Risk,” “volatility” or
“market risk,” affects the overall
market, not just a particular stock or
industry.
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19.  This type of risk is both unpredictable and
impossible to completely avoid. It cannot be
mitigated through diversification, only through
hedging or by using the right asset allocation strategy.
 Sources of Systematic Risk
Interest rate changes, inflation, recessions and
wars all represent sources of systematic risk
because they affect the entire market.
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20.  Beta is a measure of the volatility, or systematic
risk, of a security or a portfolio in comparison to
the market as a whole.
 Beta is used in the capital asset pricing model
(CAPM), a model that calculates the expected
return of an asset based on its beta and
expected market returns.
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21.  The capital asset pricing model (CAPM) is a
model that describes the relationship between
systematic risk and expected return for assets,
particularly stocks.
 CAPM is widely used throughout finance for the
pricing of risky securities, generating expected returns
for assets given the risk of those assets and calculating
costs of capital.
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22.  A risk pool is one of the forms of risk management mostly
practiced by insurance companies.
 Under this system, insurance companies come together to
form a pool, which can provide protection to insurance
companies against catastrophic risks such as floods,
earthquakes etc.
 The term is also used to describe the pooling of similar risks
that underlies the concept of insurance.
 Risk pooling is an important concept in “Supply Chain
Management”.
 It measures by either the standard deviations or the
coefficient of variation
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